NEW YORK--(BUSINESS WIRE)--Fitch Ratings expects L-3 Communication Holdings, Inc.'s (L-3) leverage metrics will deteriorate following the divestiture of the company's Marine Systems International (MSI) business, which is scheduled to be completed in the second quarter of 2015. The company announced the sale of MSI for approximately $300 million on Dec. 16, 2014. The proceeds from the divestiture will be used for share repurchases, increasing the company's previous guidance from $500 million to $800 million.
Fitch expects the company's leverage metrics will deteriorate to approximately 3.1x immediately following the divestiture of MSI, up from 2.9x at Dec. 31, 2014. Despite aggressive cash deployment towards shareholders, the anticipated weakening of leverage metrics will not have an immediate impact on the company's ratings. Fitch considers the expected deterioration will be temporary and anticipates the company will address it within one year either by bolt-on acquisitions that will bolster its EBITDA or by debt reduction. The company has the financial flexibility to pursue both strategies as it expects to have approximately $750 million in cash at the end of 2015.
The divestiture of the MSI business will not have a significant impact on cash generation due to MSI's low margins. The ratings are supported by Fitch's expectation that leverage metrics will be reduced within one year, a strong liquidity position, Fitch's expectation of solid margins, substantial free cash flow, and an increasing percentage of international military and commercial sales which accounted for 29% of sales in 2014, up from 27% in 2013.
The ratings and Stable Outlook are also supported by the stabilization of U.S. military spending over the past two years. The DoD budget proposal for fiscal 2016 requested $34 billion more funding than allowed by the spending caps under the Budget Control Act. Even if the current proposal is not approved, the sequestration-capped budget in fiscal 2016 will be higher than that of fiscal 2015, representing the first increase in the total DoD budget since fiscal 2012. Fitch's base case projections incorporate the sequestration level budget for fiscal 2016 and beyond.
Fitch would consider a negative rating action if the company's leverage (debt / EBITDA) or FFO adjusted leverage remain within the ranges of 3.0x - 3.2x and 3.5x - 3.7x over the next one year, respectively. Aggressive debt funded acquisitions or share repurchases could also result in a negative rating action. Other metrics in addition to leverage would also be considered in determining negative rating actions.
Fitch is not likely to consider positive rating actions over the next several years because of Fitch's expectation that the company will maintain credit metrics commensurate with its current ratings and will sustain aggressive cash deployment strategies in the form of share repurchases and dividends.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'2015 Outlook: Global Aerospace and Defense' (Dec. 17, 2014);
--'L-3 Communications Holdings. Inc. - Ratings Navigator' (Dec. 9, 2014);
--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014).
Applicable Criteria and Related Research:
2015 Outlook: Global Aerospace and Defense (Traffic and Order Backlogs Trump Fuel)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=837628
L-3 Communications Holdings, Inc. - Ratings Navigator
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=830228
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
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